How to Save Thousands by
Moving Your Business Offshore
By Mark Nestmann
Dear Jackie,
Tax rates are going up in 2011. If Congress does nothing before Jan. 1, 2011, you face federal taxes as high as 39.5% on ordinary income (plus the Obamacare surtax on high earners).
However, if you own a bona-fide offshore business, you can legally defer a substantial chunk of its income from current U.S. tax. (I cover this and more in Chapter 5 of my book,
The Lifeboat Strategy.)
You need a pro to guide you through. I’ll tell you how, but first let me give you an example.
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Toys, Inc. Goes Offshore!
Here’s a simple example. You contract with an incorporation company on the Caribbean island of Nevis to establish an international business company (IBC) to operate a Web site that sells discount toys. Let's call it "Toys, Inc." (Nevis happens to be where we incorporate a lot of IBCs…but it could be Belize, the British Virgin Islands, or numerous other offshore jurisdictions.)
Let's say that Toys, Inc. is a success. It generates $200,000 in profits the first year. If these profits represent the actual net proceeds of a genuine offshore trade or business, the entire $200,000 can qualify for tax deferral. Assuming you're the 100% owner of Toys, Inc., that means you could save up to $79,000 in federal income tax in 2011, at a 39.5% top tax rate.
That's a hefty savings, but to achieve it, you need to know how to navigate the U.S. tax code properly.
A Tax Expert's
Guide to Business Tax Savings
Rule #1: You Must Understand Controlled Foreign Corporation (CFC) Rules.
If we go back to our example, Toys, Inc. isn't a U.S. corporation. So the IRS has no authority to tax it. However, in certain circumstances, it has the authority to tax the U.S. owners of a foreign corporation on income the corporation generates, with no opportunity for deferral.
I’ve boiled down the CFC rules into one general principle:
A U.S. person who directly or indirectly owns a 10% or greater interest of the stock in a foreign corporation in which more than 50% of the shares are held by U.S. persons can defer paying tax on the offshore profits of that corporation only on the "active" income from the business...
For passive income (interest, dividends, etc.), no tax deferral is generally possible. When you invest untaxed offshore income from a foreign corporation in an offshore bank account, securities account, etc., you can't defer tax on that income.
Even if Toys, Inc. does achieve tax deferral for its offshore profits, if it's classified as a CFC, there may be unpleasant tax results down the road. However, if you can defer tax on the profits for a long enough time, you may be willing to deal with these results, which include:
- Profits repatriated to the United States are taxed at your marginal income tax rate. The 15% income tax rate on capital gains and dividends isn't available.
- You can't deduct business losses a CFC until you liquidate it.
- If you die while you're a shareholder of a CFC, your U.S. heirs lose the ability to step up the basis of the stock to its fair market value. When they sell the shares, they'll pay tax on their value when you acquired them, not when they inherited them.
Rule #2: Make Sure You Have a Bona-Fide Offshore Business.
The IRS also has the authority to tax "U.S. trades or businesses" that generate "effectively-connected income" within the United States. That means Toys, Inc. must be a bona-fide offshore business. Ideally, it should have a staffed office that operates the business outside the United States.
After you set up the company, your role (if you live in the United States) should be limited to being a passive investor. Toys, Inc. shouldn't have a U.S. office or employees working in the United States. Nor should it have any U.S. agents working exclusively to market or distribute its goods in the United States.
Rule # 3: Know Your Reporting Requirements
As you can see, achieving tax deferral in a foreign business requires careful tax planning. You'll want to consult with an international tax attorney before you assume Toys, Inc. can generate tax-deferred profits.
Complex reporting requirements also apply. At minimum, you'll need to file the following reporting forms:
- Form 5471 (tax return for a foreign corporation)
- Form 936 (when you capitalize the corporation)
- Form TD F 90-22.1 (to report the corporation's offshore accounts over which you have signatory or "other" authority).
Make Sure You Understand the Benefits
When done properly, a bona-fide offshore business can save you a bundle in taxes in 2011 and beyond. You can defer these taxes and re-invest that $79,000 (in the case of Toys, Inc.) in your business. Tax-deferred growth is a major advantage of doing business offshore in a bona-fide offshore business.
Tax deferral is becoming increasingly difficult in a time of government “cash grab.” But there are still legal loopholes for U.S. citizens willing to go the extra mile. Those who will do their homework, keep it legal, and pay the price of setting up proper structures will benefit in the long-run.
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Mark Nestmann
Wealth Preservation and Privacy Expert
